Friday, August 26, 2022
Should Canadians save or pay down debt first? Find out which option makes sense based on your debt-to-income ratio, emergency savings, and high-interest debt obligations.
Choosing between saving money and paying off debt is a financial dilemma many Canadians face right now. The cost of living is high, making even the simple things pricier. What should you do when housing, food, and other basics consume more of your income?
High-interest debt like credit cards can cost you more money over time if left unpaid, making aggressive repayment seem like the obvious choice. Then again, what happens if an unexpected expense hits and you have no savings to fall back on? You might end up right back in debt.
This guide will help you evaluate your situation and see which is best for you.
Not all debt costs you the same amount of money. The type of debt you carry determines whether you should aggressively pay it off or focus on building savings instead.
Credit cards and payday loans are the best examples of high-interest debt. Most credit cards charge around 20% in interest. A payday loan is often more than twice that.
This means your debt grows rapidly and costs you significantly more than you borrowed over time.
High-interest debt should almost always be your first priority.
Personal loans and lines of credit usually carry interest rates less than that of a credit card. The interest rates on these kinds of debt can vary but are usually between 5% and 15%.
These debts cost you money, but not as much as credit cards do.
Many with medium-interest debt are able to balance saving a little while paying down the debt at the same time.
Student loans and car loans are examples of debts that often have low interest rates. In fact, the government of Canada has stopped charging interest on the federal portion of student loans.
Even car loans often have an interest rate of between 5% and 10%, with new cars often costing less interest than that of used ones.
The cost of carrying these debts is relatively low, making it easier for you to plan to save money.
Of course, it’s not always about what kind of debt you have, but how much debt you have overall.
Your debt-to-income ratio measures how much of your monthly income goes toward debt payments. This number tells you whether your debt load is manageable or if you're in financial trouble.
To calculate your debt-to-income ratio, add up all your monthly debt payments (credit cards, loans, mortgage, car payments) and divide that total by your monthly income. Multiply that by 100 to get a percentage.
You can use our calculator below to help you find your own debt-to-income ratio.
How much debt is too much? Use our debt-to-income calculator to find out what your ratio is.
Calculate your debt-to-income ratioIdeally your debt-to-income ratio is below 30%. This means less than 30% of your income goes toward debt payments, leaving you enough money for savings, emergencies, and daily expenses.
A concerning ratio falls between 30% and 43%. This shows you’re spending a significant portion of your income on debt, which limits your ability to save money for the future.
A bad debt-to-income ratio is anything over 43%. This means somewhere around half, or possibly even over half, your income is going toward servicing your debt.
So, once you know what debt you have and how much you’re spending on it, what should you do?
You’re in a good position to save money if your debt payments are taking up less than 30% of your income.
This shows you’re managing your debt well and can prioritize savings for future goals without sacrificing your financial stability.
If the majority of your debt is from things such as car or student loans, then you’re in a good position to save money.
Low-interest debt is much less of a drain on your bank account than debt from a credit card or payday loan.
If you have zero savings and an unexpected expense hits, you'll likely need to borrow more money to cover it. This is a situation you want to avoid.
You want to build at least $1,000 to $2,000 in emergency savings before aggressively attacking your debt.
This prevents you from falling deeper into debt when life throws you a curveball.
If the reason that you don’t have an emergency fund is because you're falling behind on debt, your debt-to-income ratio is likely too high and needs immediate attention.
If you have credit card balances or payday loans, focus on eliminating these first.
High-interest debt costs you far more over time than any interest you'd earn from putting your money into a savings account.
Paying off a credit card charging 20% on interest saves you more money than putting that cash into a savings account earning 3%.
If more than 30% of your income is going toward paying off debt payments, it’s a sign that your debt is becoming unmanageable and you need to address it.
Having such a high debt-to-income ratio limits your financial flexibility.
You’ll want to prioritize reducing how much you’re spending on debt before you think about building substantial savings.
The sooner you lower your debt payments, the easier it will be to save money.
Financial stress takes a real toll on your well-being. About half of Canadians have lost sleep due to financial worry.
If debt keeps you up at night or causes constant anxiety, paying it down can provide enormous relief.
The psychological benefit of reducing debt, and the worry and anxiety that comes with it, often outweighs the advantage of saving money.
If you've read through this blog and realized you can't afford to do either (you can't save money, and you're barely keeping up with debt payments), it's time to explore your options with one of our Licensed Insolvency Trustees.
Our Licensed Insolvency Trustees provide judgment-free consultations to help you understand what's possible. Whether you're drowning in high-interest debt, you have a high debt-to-income ratio, or you simply can't see a way forward, we can help you find a solution that works for your situation.
Your consultation is completely free and confidential. There's no obligation to sign anything. Contact us today to take the first step toward financial freedom.
Friday, August 26, 2022
Should Canadians save or pay down debt first? Find out which option makes sense based on your debt-to-income ratio, emergency savings, and high-interest debt obligations.
